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One percent responsible

Longtop Financial Technologies, a Chinese financial software company, was a notorious financial fraud (see here for a NYT column on the discovery of the fraud). Both its outside auditors, Deloitte Touche Tohmatsu, and its Canada-based CFO, Derek Palaschuk, were apparently taken in by the company’s scheme to exaggerate its cash balances and revenue, under-report bank loan balances, and hide employee costs in an off-balance-sheet entity. Last year, a securities class action brought on behalf of investors in Longtop’s American Depositary Shares obtained an $882.3 million zl against Longtop and its CEO, but Palaschuk decided to take the claims against him to trial.

On Friday, after a short trial in New York federal court, a jury found Palaschuk liable for securities fraud based on his failure to act despite the presence of “red flags” indicating that the company’s accounting might be fraudulent. According to press reports, the inability to compel the presence of Chinese witnesses meant that Palaschuk was the only fact witness to testify. Because Palaschuk’s liability was based on recklessness (rather than actual knowledge of the fraud), however, he presumably was subject to the PSLRA’s proportionate liability provisions. Under these provisions, he only could be liable “for the portion of the judgment that corresponds to [his] percentage of responsibility.” In an interesting twist, the jury reconvened today and found that Palaschuk was only 1% responsible for the fraud, assigning the other 99% of the responsiblity to Longtop and its CEO. According to the plaintiffs, that still means Palaschuk will owe at least $5 million. Palaschuk plans to challenge the verdict. Stay tuned.

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